The Russian Economy after YUKOS

MR. ARON: We are all set. We have Yegor Gaidar, and the sooner we start, the sooner he will speak, and the more questions he will be able to answer.

Before I do my introduction, I wanted to draw your attention to Yegor Gaidar's newly translated book fr om University of Washington Press, State and Evolution. These are the two sample copies. Don't take them. But there are--there is order information at the front desk as you get out of the room. We have plenty of those order forms, so please feel free to take them and order them.

There is another one, and this is fr om MIT Press. It's edited by Yegor Gaidar, and it's called the Economics of Transition, and a veritable, veritable encyclopedia of political economy and economic economy of the Russian transition. This is what the book looks like, and it is fr om MIT.

How many times have we all heard that the speaker needs no introduction? And in most cases, we take it for what it is, a very tired cliche, and we brace ourselves for an introduction that invariably follows.

There is, however, a very rare category of speakers whose introductions are not ritual. They do need an introduction and not because they're unknown. Usually it's the opposite. But because of who they are and what they have done with their lives are so fascinating and important, and the closer, the better the introducer knows the speaker and the more the true scope of merit and achievement becomes apparent, the easier for the speech to become very long.

But by a fortunate correlation, it is precisely such people that everyone, particularly the introducer, certainly in this case, are so eager to listen to that an introduction, no matter how tempting, seems a distraction. And this is where I find myself with Yegor Gaidar, between the urge to tell you at least some of what I know about this remarkable man and the desire to let him speak as soon as possible and as much as possible.

Well, everyone here, just by virtue of your being here on a January afternoon, knows the basic outline of what to me is a veritable epic of our days: a 35-year-old minister of economy and then deputy prime minister and then the acting prime minister who tore the Russian economy away fr om the rapacious, incompetent and utterly corrupt Soviet state; abolished price controls and with it the daily indignity of lines and shortages; saved Russia fr om the widely-predicted and in fact expected famine in the winter and spring of 1992; a true revolutionary who, like every true revolutionary, has bitter enemies and passionate haters but also a man of such integrity that no one, including those very same haters, has ever accused him of misappropriating one kopeck of state money.

Then, there is Gaidar the politician, the founder and the co-chairman of Russia's true, consistently correct Party of Economic Liberalism. Fewer people, I think, know, although probably not in this room, know of Gaidar as the first-rate scholar and master economist and the very fine economic theorist--incidentally, those books that I introduced are yet another proof of that--and the director of one of the leading centers for the studies of economics in transition.

Now, still fewer, I think, except for those who were there at the time or, like myself, watched the documentary footage, are aware of a Gaidar of rare physical courage; incidentally, the quality that for all their differences, he shared with his former boss, Boris Yeltsin, for it was Gaidar who, on the night of October 3, 1993, tipped, I think, the scales of the incipient civil war by inspiring, organizing and leading 30,000 unarmed men and women in the center of Moscow who, nevertheless, were ready to take on the black-shirted Stalinist thugs with Kalashnikovs; the latter, running around under the red flags, chanting motherland, socialism, USSR, and shot at passers-by just for fun fr om the parliament building, killing scores.

Still fewer, because of Yegor's passion for privacy, know him as a generous, gracious and enchanting dinner host. And this is all the time that I allotted to myself to prove the thesis with which I started, namely, how important it is but also how difficult it is to introduce Yegor Gaidar.

Yegor?

[Applause.]

PRIME MINISTER GAIDAR: Thank you very much.

Dear friends, it is my privilege to address this audience. Thank you, Leon, for the words about me. Usually, this is being told, this type is speech is only possible at a funeral.

[Laughter.]

PRIME MINISTER GAIDAR: But I know that you are sincere.

Well, I know that you discussed a lot of the developments in the Russian economy, and I think you know very well the statistics, and I would--the general economic situation is really stable, and it's not everything oil and gas, and the results of 1993 were more positive than anybody expected, seriously, so I will not speak about all of this.

I was asked to concentrate on a really, fr om my point of view, important topic, strategically important, and that is the interconnections between the developments around YuKOS and the economic developments in Russia. I think--and I will try to concentrate exactly on this topic, but as the topic is complicated and long, I will have to use some of your time and start from the beginning.

Well, to some degree, the YuKOS problems last year were positively correlated with the fact that YuKOS, after 1998, when the battles connected with the ownership were more or less completed, decided correctly that now, it would have to transform itself into a transparent company with a good reputation in the West; and by doing this, it will radically improve its assets in the capital markets; potentially, its capitalization and potentially would create the basis under which it would convert itself into one of the leading oil companies in the world.

It was a strategic solution, and the management of YuKOS was tough. But a majority of the people there were quite clever and competent. So when they decided this, they started to move in this direction and invested money in public relations, really showing that they are trying to be transparent; inviting the people with perfect reputations in both management and on the board of directors, et cetera.

And the conversion of Khodorkovsky from one of the terrible heroes of the robber baron stage of development of Russian capitalism to the perfectly respectable gentleman with a very good reputation was just a matter of three to four years. And after this, there was a rapid increase of the capitalization of YuKOS, a radical change of the attitude of the investment community to the company, et cetera.

But then, they were confronted with the fact that to resolve these problems, you do not only need to change yourself. You, in a serious way, have to change Russia. First of all, in many fields, Russian legislation, especially in the tax field, was so distorted that it was the habit of the vast majority of the companies to use various legal or semi-legal, usually legal, existing but, of course, not very efficient for the state ways which would allow you to minimize taxation.

A lot of things that were done by YuKOS and by, I think, a vast majority of the big Russian oil companies was the reaction on a very distorted tax system wh ere you have, for instance, frequent turnover taxation, which is quite unusual in the world; turnover not meaning the turnover; the amount not of profits but the amount of the turnover.

And, of course, a significant part of all of this transfer scheme was to avoid it. In a situation wh ere you have the combination of a marginal tax rate on income of 30 percent and a 39.7 percent various kinds of taxes for social funds, et cetera, et cetera, et cetera. So they decided that, well, we are competent enough; we know how to do it. Let's try to address these problems.

And also, they had, because it was the other way around, they could not be transparent. And if you will not be transparent, then, we will not be able to use our comparative advantages. But more than this, they understood that the capitalization also depended on how Russia is perceived in general in the world, whether the property rights are defended; whether there is a land code which makes property legally well-defined, et cetera, et cetera, et cetera.

So they were prepared to do the things which they were absolutely unprepared to do in 1997: they were prepared to use a lot of efforts to improve the situation in Russia, and of course, also, as you would understand, to defend their own interests, because they are not a philanthropic organization. They are a big, aggressive oil company.

In 1997, we, as a so-called young reformer government, of which I was never a member but with which I closely cooperated, we elaborated a program of reforms which was very close to the program that was implemented later by Putin. It is easy to see. It was a little bit less radical, because we knew that we would not get political support from a radical program, and that's why we elaborated it as more radical in 1999 during the Primakov government, exactly because we thought there was a zero chance of pushing it.

So we thought that why should we accept all of these compromises? Let us elaborate the program like we see it; and then, maybe, sometime, somebody will need it. This situation developed so that, as we never expected, it was needed in the early spring of the year 2000, and that was the basis of what was done during 2000-2001.

A good point was that a lot of things which were in our program generally were compatible with the interests of the oil industry, especially of the companies which would like to be more transparent. They would like to have a lower marginal tax rate. They would like to have more transparent tax administration. They would like to see the clear property rights, et cetera. They would like to see elimination of the turnover taxation. They supported the idea of the flat income tax. And to tell you frankly, I don't think that we will be able, even with the governmental and the Kremlin support and the realities of late spring, early summer, 2000, to push so radical, for instance, tax reform as we were able, because we closely cooperated with the oil lobby.

The oil lobby was not only YuKOS, but YuKOS was the leading force in this lobby. The person to whom I have a very high respect, who is extremely intelligent and competent, who is, by the way, a professor of theoretical physics by personal experience and training, Vladimir Dubov, who was, before YuKOS started to fall, also a billionaire was nominated as the chairman of the Tax Committee, and we had a very fruitful, practical cooperation and from my point of view, a lot of the successes of the tax reform of 2000-2001 were connected with this intensive cooperation.

By the way, the oil lobby was not, at the time, by far, the only lobby in the Duma, branch lobby, and even, at the beginning, not the strongest lobby. The strongest lobby at the beginning of the work of the Duma by tradition was the Gazprom lobby. And then, we had a very strong agricultural lobby. Then, we had a very strong lobby connected with railroad construction money. Then, we had a not as strong but existing lobby connected with alcohol production and a list of other, less important lobbies.

Even with the help of the strong support of the oil lobby, with the position of the agricultural lobby and the road construction lobby and the more or less neutral position of the Gazprom lobby, it was possible for us on the crucial words to get three, four, what's more than is necessary to get the majority. So by far, at the beginning--

[Technical interruption.]

PRIME MINISTER GAIDAR: But then, two things coexisted, went together. First, after the change of the leadership of Gazprom, Gazprom practically lost serious influence in the State Duma. The new management were unable to get the previous connections.

And then, the oil lobby, which had a very competent personnel, was able, step by step, step by step, to convert itself into a clearly dominating force in the Duma, which was either impossible or extremely difficult to contradict. When the oil lobby had some decision and some interests, only the direct intervention of the President could help to change the result of the vote.

And once again, during this time, there were happening a lot of helpful things: the Land Code, the turnover of agricultural land, a new labor code, pension reform. All of this was done, in all of the key meetings in which I was in all of these issues, usually, they were present, and their position was constructive.

But also, of course, as any lobby, they were strongly defending their interests. So they were prepared to go to the system which is more or less an open and transparent model, but if it is, in a broad way, compatible with the stability of these structures, including in the situation of risks, because you know that oil prices fluctuate, and they wanted to be sure that even if oil prices go very low, they would be confronted with problems but not with a catastrophe.

So all the time, they were thinking about a worst-case scenario.

In many places, when improvements were evidently necessary, they were able to block them; for instance, an enormous problem of the Russian tax system is transfer pricing, operations under which you can minimize your tax obligations by using prices which are evidently lower than the market price. And in all of our tax reform programs, we had amendments to the first part of the Tax Code which would eliminate these loopholes. Nothing doing. Usually, it was possible to bargain with them; no point for budging.

In many other fields, for instance, elimination of tax-privileged zones for the profit tax in the regions; generally, yes; generally supportive but not--but with the amendments which will allow those offshores which suit their interest to operate for an additional three years. So a normal lobby is not from the angels and not from the devils; usual as in any other parliament, especially in a presidential republic.

But then, the problem is that power corrupts, and absolute power corrupts absolutely. When you are starting to be the dominating force in the parliament, you sometimes are using it in an excessive way. And it was evident that starting from 1992, the oil lobby was starting to use their influence in an excessive way, sometimes only to show who is the boss.

They, being also very qualified people, studied the practice of lobbying and lobbying techniques here in this town. So they got the art which is especially unpleasant for any government, and that is the art of, exactly in the moment when you have legislation which is essential for you and which you absolutely cannot veto, unexpectedly, in the second reading, from the floor, to introduce amendments which then will be voted on and supported, and you hate these amendments. They are not good. But there is nothing you can do to veto it, because you need this law.

And they used this practice a few times, not all of the time but a few times during 2002, and they were using them in 2003. So the turning point--I never was told so by anybody in the government, but I participated in the debates in June, and I think my picture is very clear, and if you will read what President Putin was saying during the last two months, you will see the proof that I am right. He was constantly mentioning the same things.

Well, it was June 2003. One of the key laws that the government has to accept is the so-called--is the tax legislation which creates the condition for the budgetary process. So if you need some changes in the tax system, and you inevitably need them because inflation is still 12 percent, you need to adjust the tax rates which are overdenominated. So you cannot elaborate the budget without this legislation, by the law. So you need it, and you cannot veto it, before the 30th of June.

So, then, first of all, there were a lot of delays on technical grounds so that the law would pass through the second reading, meaning the third reading on the 30th, second reading only on the 21st of June, and then, there was an extremely intensive debate about additions and changes in the law which are necessary to get the support of the oil lobby.

The funny point was that it was not about money. Money, which was at stake, was 3 billion rubles, $100 million; generally, these guys could leave it as a tip in a restaurant and would not be harmed seriously. The problem was about who is the boss. And during 72 hours, I personally was trying to negotiate some kind of face-saving compromise. And I negotiated, from my point of view, a face-saving compromise. And the law was adopted in a variant which was more or less agreed between the government and the--but it was very much a compromise on the terms of the oil companies.

Well, every government in a presidential republic is confronted with these type of problems, and there is a way of dealing with which governments can do more efficiently or less efficiently. You are accumulating your structural support. You are combining the efforts of other lobbies. You are inviting the influential members of the Congress. You are telling them that their support, their cooperation with the government, the president depends on the position of this extremely important law. So it is nothing new.

But let us remember that we are a young democracy, and I had a very bad feeling in late June about all of these issues. I thought that the results could be disastrous. And I'm sorry; I was right. Because you can do all of these sophisticated ways, use all of these sophisticated ways to fight the lobby, or you could just use the Russian way: who is the boss? I will show you who is the boss. You try to tell me who is the boss? I am the boss.

And that, from my point of view was the reason of all of these further developments. Well, YuKOS' leadership was extremely surprised. They did not expect it at all. They miscalculated the situation, because they thought that they were trying to resolve the problem of who is the boss with the Minister of Finance, and they would not understand that somebody much higher could decide that they are trying to resolve the problem of who is the boss with him.

And that was, from my point of view, how it was understood. And starting from here, you have all of these developments. Well, short-term consequences: one of the YuKOS leaders visited my office, because he usually highly estimates my opinion on economic development two weeks before Khodorkovsky was arrested and asked me what would be the macroeconomic consequences of further pressure on YuKOS? And I had to answer him that if I would be entirely cynical, and would be only interested in the short-term macroeconomic developments, I would tell you that it is the best way I know to fight against excessive capital inflow in the country under the present circumstances.

I was a little bit overoptimistic. And if I would be the chairman of the Central Bank, and he is my good friend, I would have my first calm sleep after knowing that this repression would continue. I a little bit overestimated it. It happened but for a very short period of time. In a three or four week period, I don't remember exactly how long it was, the effect was more or less eliminated.

From the political point of view, of course, the result was the increased popularity of Putin. You could probably understand that the oligarchs are not the most popular guys in Russia. As in many countries, the richest persons are usually not so much liked. And when you push and put in the jail the oligarch, of course, you could get additional popularities. So the problem of the first round was easily resolved.

Well, in the political field, the result was the defeat of pro-democratic factions. It was closely interconnected; you see, we had to have the position, and on moral grounds, we had no chance to tell, well, everything is okay; nothing happens. So we had to take a quite strong position, knowing that it is absolutely disastrous from the point of view of the elections, because we fully understood that half of our electorate, at least hated Khodorkovsky-type people; that they generally like Putin; that they would not like to be in any way in opposition. So we were left with our core electorate, which was very pro-Yeltsin, pro-democratic, et cetera. And that was not enough for victory. Our victory in the previous electorate was based on the ability to bring out the core Yeltsin electorate and a new, business-oriented, pragmatic, not very ideological, not very much caring about human freedom part of the electorate.

So, now, we were inevitably splitting this electorate, and the results were more or less predictable.

Well, so, from this point of view, the short-term, no consequences. The problem is not with the short-term. The problem is with the long-term, and here, the situation is much less clear and much less predictable.

The task of the reform of the programs which we were trying to implement, starting from 2000, was in some way to convert Russia into a dull country, into a predictable country. Of course, we needed to improve the tax system; to improve the protection of property rights; the customs regime, et cetera, et cetera, et cetera, et cetera. But first of all, to bring both Russian capital in Russia and foreign capital in Russia, not in the form of short-term investment, which could fly the second day, but in the form of long-term investment, both local and foreign.

For all of this, you need first of all predictability, a sensible system but first of all predictable. China is in no way a champion in democracy. But it attracts an enormous amount of investment, foreign direct investment. Why? Because it is predictable. It is regarded by the investment community as a predictable country. Well, you know the rules; you know that they will be stable, et cetera.

I'm addressing significant parts of the investment community. So I would not probably be surprised if I told you that usually, you are pragmatic people. You are hired to earn money and not to fight for democracy. So, democracy is our problem; predictability is our problem and your problem.

So, all the time, I tried to fight for the predictability of our decisions. We had to pay high prices for this. I will just give you two examples: we were unable to eliminate turnover taxation immediately. We cut it down from 3.5 to 1 percent starting from 2001. And we then included it in the law that we will eliminate entirely turnover taxation, if I do remember correctly, from January 1, 2003.

Here is one of the examples wh ere success creates problems. Together with other changes in the tax system, the lowering of the rate decreased very seriously the stimulus to avoid this tax, and the revenues started to grow so much that then, we had to eliminate this 1 percent of revenues; they were close to 3.5 percent a year ago. So when we were told why should we eliminate, who is harmed by this 1 percent tax: it brings us enormous revenues; it is helping us to finance road construction; my answer, and we had--it was one of the key battles of the time--and my answer to all of this was that we told the society, the investment community, and included it in the law that the tax will not exist starting 1 January 2003. And all of the revenues we are getting are not worth making the signal that Russia, once again, is unpredictable; that what is in the law does not matter.

We had a similar battle this year about the sales tax, because also, it was in the law a long time ago that it will be eliminated January 1, 2004, and we had an enormous battle about this in the spring. And my argument also was we made these solutions. We included it in the law. This $2 billion that we are collecting on this tax are not worth a situation in which, once again, Russia would be an unpredictable country. And then, you are making Russia once again look extremely unpredictable.

I met with--of course, a very important point is that in 2003, we had evident signs that we are starting to get results from this policy, that we are starting to go from recovery growth, which we had between 1999 and 2002, to investment-led growth, which looks like we started to have in 2002, a very rapid increase of investment; a very rapid increase in the machine-building industry; a very rapid increase in the machine-building imports. All of this usually goes with investment-led growth.

Big deal between BP and TNK, the biggest direct investment in Russia during all of the transition period; serious discussion between YuKOS and Exxon. I think that three weeks, approximately three weeks or four weeks before Khodorkovsky's arrest, one of the Exxon executives was in my office, and he was absolutely sure that the deal will be done. He told me that the only problems which are left is the price, and that will be the problems of the direct negotiations between Khodorkovsky and the chief executive of Exxon and that they are quite sure that they were given the green light from the Kremlin during the Putin visit to New York. So they were extremely optimistic.

At the same time, I had a chance to meet with a few chief executives of the very big international companies, and usually, of course, they are connected with the extracting sector but not only with oil. And I could understand their mood: they were not discussing the point of whether they should or should not invest in Russia. In all of this environment, it was evident for them that they could not afford not to invest and be regarded as global companies. So they were asking how? Who are the potential partners? What should be the priorities? What should be the worries? What should be the timing, et cetera? That was--even after Pavel Lebedev was in jail but before Khodorkovsky was arrested.

Then, we have the arrest of Khodorkovsky and inevitably the collapse of the Exxon-YuKOS deal, followed then by the collapse of the YuKOS-Sibneft deal. Of course, I know very well--some of you know it even better, but I know very well how the big strategic investors are making their solutions. Portfolio investors are very rapid in their solutions. They could come in, come out; come in, come out. And they need to make very rapid decisions, and there is a culture of making very rapid decisions.

When you are speaking about big, strategic investors which are prepared to put billions of dollars for decades, they are all the time very slow. They have to understand the ground. They have to make at least some understanding of the country, how to work with the country, assess the potential benefits and risks then to start the long-term process of intercorporational discussions, et cetera.

So it is very difficult to make them going, to start. But also, as big ships, it is very difficult to stop. So when they decided something, it is very difficult to tell, well, all of this nonsense, all of this effort was a mistake, et cetera. So I don't think that the Khodorkovsky affair itself will result in a change in many kinds of projects, but it will put a very big question mark, and especially a very big question mark when the decision is not already made. That is my impression on what signals I am getting from the investment community during the last two months.

Authorities, when they made the decisions, they never understood the consequences. I can see the logic, well, what is all of this about? I am putting the persons who probably have broken some law during the privatization period in jail. I am implementing the law.

Why all of this fuss? Why all of this reaction? And of course, I usually tell that you can defend two lines: one lines is that it is purely law enforcement. So, why bother? And you can defend it. You can defend another line, that all of this is a unique case; it will not be repeated, and you should not worry. It's another line. You also can defend it. The problem is that the Kremlin is trying to defend both lines, and it is very difficult.

So, what authorities are now trying to do is they're trying to push their way down to tell, well, in the private discussions, to tell, well, it is a unique case. You should not think that it is the start of the process. It will not be the start of a process. All of the other companies will work normally. We will not start a review of the results of the privatization. And I think they really would like very much to pursue the community in this.

The problem here is connected with the fact that Russia is a big country, and it has a big bureaucracy and a big bureaucracy far from Moscow. And this bureaucracy is not reacting to what you do tell. This bureaucracy reacts on what you do. And if it could happen because of the political reasons, not everybody are fools in Russia, because it could happen because of the political disagreements to the richest person in the country, why, for instance, if I as a governor of a province has a political disagreement with a businessman who, for instance, does not support my election funds so energetically, why could I not ask him to my office to ask him whether he knows whether Khodorkovsky is now sitting [in jail] and whether he will contribute, and the chances that the answer will be positive are radically higher in the situation which emerged during the last half of the year.

And that, of course, creates an enormous amount of unpredictability in property rights which we tried to eliminate during all of these years. So, from this point of view, of course, nobody can tell how damaging the effects of this will be. Nobody can tell now whether the investment-led growth which started last year will survive this challenge. Nobody can know how efficient the authorities will be in pushing down all of this and trying to put clear signals that it will not be repeated. We will see.

But one thing is, for me, quite clear: when I visited Australia a few years ago--and I loved the country; it's splendid--I was surprised the degree to which the country elite is frustrated by the fact that nobody in the world cares about what happens in Australia.

[Laughter.]

PRIME MINISTER GAIDAR: And I had a dream to have at least for some time that Russia is a country that nobody in the world cares what happens in Russia--at least for two decades, we were so much at the center of attention in the previous century, I could think that we could afford two decades of being absolutely unnoticeable in the world. And to tell you, frankly, all the things that I have done during the years were to make Russia a dull country. And at the beginning of the year 2003, by my discussions with, for instance, the international press who are covering Russia, I got the impression that Russia starts to be a dull country.

They were complaining, well, nobody is interested in what happens in Russia, about what should we read? Nobody is publishing what we are writing. Now, one problem is solved. Russia is once again a very, very exciting country.

Thank you.

[Applause.]

MR. ARON: Okay; we have about 15 minutes for Yegor to answer questions. I will be directing them there once you raise your hand and introduce yourself.

Bernie Sucher.

MR. SUCHER: Bernie Sucher, Alfa Capital.

What process could you imagine we will be learning about as for the disposition of YuKOS property as this trial unfolds? What kind of mindset is going to prevail in this disposition?

PRIME MINISTER GAIDAR: The question absolutely continues my last statement: the answer is I don't know. And if I do understand correctly, nobody knows.

MR. KALPE: Jack Kalpe of AEI. After I read Leon's biography of Boris Yeltsin, I was persuaded that deep inside, Yeltsin wanted a free society and a liberal economy.

What does Putin want?

PRIME MINISTER GAIDAR: From my point of view--of course, it's better to ask Putin--

[Laughter.]

PRIME MINISTER GAIDAR: --but I have a quite clear view on this. He's for a liberal economy, but he's very skeptical about democracy in Russia at the present stage. It doesn't mean that he's genuinely against democracy or that he's genuinely against democracy in Russia ever, but he doesn't think, from my point of view, that Russia needs a functioning democracy. Of course, democratic entourage, yes, but functioning democracy, when the people really decide, no.

MS. GADIA: Toby Gadia. Yegor, you talked about predictability and the lack of it now, but there are certain things that are predictable: one is an increased state role and the direction of the economy. Certain decisions are not going to be made by the private sector but will be made by the state. Can you explain the parameters of not the fight over private property; I don't think that's the main issue. It's really who decides wh ere investments are made and what kind of Russia, what kind of economic system within a society wh ere there is private property, but the decisions are strategic decisions? And can you talk a little bit about how those would be made if they're not going to be made only on an economic basis?

PRIME MINISTER GAIDAR: Toby, this book is about this kind of problems. It was written much earlier, but essentially, it is about this. So yes, of course, there are some things which are more or less possible to predict; for instance, whether you have the privately-financed and privately-owned pipeline to Murmansk. A year ago, when we discussed it with Khodorkovsky, I thought that it was quite possible. Now, my answer would probably be no.

Another thing, whether we will see serious disruption in Gazprom, really free access to the pipelines by independent gas producers, a year ago, I would tell you that I'm practically sure that step by step, it will be done. Now, my answer is I do not believe in it very much.

So, of course, some things are already started. I don't think that it is the issue of Putin to move in this direction. He's generally liberal in economic policy. But some things are not being resolved by what he would like to have but by the signal you have already delivered; for instance, civil society, from my point of view, one of the key tasks now is to keep the civil society mechanism functioning, even in the new political environment, because it's extremely important for the future development of democracy in Russia.

But, well, I will use two minutes to tell you a story. One of the very famous investors who put a lot of money in charity in Russia three times had a discussion with me last year whether I think that now, when there were a lot of rich people in Russia who are started to be engaged in charity projects, he has the moral right to withdraw. And I told him yes, I think you have done a splendid job in charity in Russia; helped in a lot of very important directions; helped to create a lot of instruments in the civil society; of course, you can.

And you have Khodorkovsky, who practically modeled all of his Open Russia Institute absolutely on the Soros model and made it knowing that he's doing it.

Well, now, those who would like to support independent civil society activities in Russia have got a very good message, which they understood perfectly, perfectly well: you should not be engaged in any financing of any kind of civil activities unsupported directly by the Kremlin. And they caught it. They understood it. So I had to send a letter to this investor and to tell him, sorry, I was wrong.

MR. ARON: Please, right there?

MR. MENSHER: Thank you. Yuri Mensher; I'm an intern here in D.C. from Moscow, Russia. My question is don't you think that the Khodorkovsky arrest and all of the corruption in the Russian economy right now are the consequences of really poorly managed privatization of the 1990s? Like, what is your point of view?

[Laughter.]

PRIME MINISTER GAIDAR: Well, privatization was done in the 1990s in a very bad way. But the problem is that I have seen no single postsocialist countries wh ere the population would be satisfied by the way in which privatization was done. I personally was the great opponent of the idea of the voucher privatization. There are a lot of my writings of 1990 and 1991 about this, and Chubais was an opponent. But then, when we were in the government, the general legislation was already adopted. We had the choice of either stopping privatization and then having a mess when the managers whom we were unable to control are stripping assets, creating new companies for their wives, transferring under the laws--the assets--or to start a very inefficient--we knew--there was a lot of enthusiasm at the time--we knew very well that the voucher privatization will not be an extremely nice experience.

But it was our perception that it was better to privatize and then to see the consequences or stop privatization. Well, I, personally, all the time defended the privatization on the variant which was more or less implemented in Hungary. And my perception is that it was more or less the best possible to resolve an unsolvable problem.

I met, in Baghdad, when I was invited, wh ere I was invited by the temporary administration, together with a few other reformers, and we had a chance to discuss it with my old friend, ex-minister and then ex-chairman of the Central Bank of Hungary, Peter Bode. And he told me there is nothing more terrible than the way in which privatization was made in Hungary.

The problem is that the task is, to some degree, irresolveable. What makes property legitimate is tradition. That's the only way. And how could you create this tradition after either 40 or 75 years of the socialist regime?

But to tell you frankly, still, I think that privatization works. This is a very complicated issue, and you do understand, probably; it's important for me, so I will use one more minute of your time. Let us take the two probably most important sectors of the Russian economy: oil and gas. In oil, we decided to privatize. In gas, formally, of course it was privatized but practically stayed as a state company. So let us look at the oil and gas sectors from 1996.

Oil: terrible mess; fights about who controls what; downfall of production; capital flight; asset stripping; underinvestment. Gas, well, of course, not perfect, but still functioning Soviet-type institution; gas production is more or less in line with the previous; some investments, of course, not perfect management but not such a mess.

Let's look at these two sectors from the position of now: oil, with all of the problems with Khodorkovsky, well-run companies; proper financial management; most important problems, how not to be in conflict with Saudi Arabia and OPEC about the fact that we are increasing so rapidly our oil production, our share in the oil market; very high level of investment; evident willingness to invest in the industry.

Gazprom: absolutely untransparent company; how treacherous manipulation with property and financial flows; very serious problems of financial position; very high debt. So, you see, privatization works, but you need much more time than, for instance, we expected.

QUESTION: Thank you. I have three very short questions: on the economic side--

PRIME MINISTER GAIDAR: If it's possible, one by one.

QUESTION: Okay; sure; Putin was saying that he would like to double the GDP over the next 10 years, and I was wondering if you think primarily, would that be focusing on the natural resources, the utilization of natural resources or more on the manufacturing side? That's the first one.

PRIME MINISTER GAIDAR: Well, of course, everybody in Russia would like to increase the share of the sectors not connected with the oil and gas and general natural resources. And that is one of the priorities of the government, and the government will try to move in these directions. Whether it will be possible or not, we will see.

QUESTION: Thank you; and the other economic question, there is slight inflation going on at least in the cities which I know, which is Moscow and St. Petersburg, and I was wondering if you think it was more seasonal, winter problem or if it was something that the government maybe made some mistakes economically.

PRIME MINISTER GAIDAR: Well, the increase of the rate of monthly inflation in January is a universal phenomenon in Russia for all of the period of transition. First of all, it is connected with the corrections of the levels of the various tariffs, which are being corrected usually in January, and partly, it is connected with the usual infusion of budgetary money in December, when a lot of the budgetary expenditures are being finalized. Also, the habit of paying a significant amount of additional bonuses in December. So by itself, it is not dangerous.

What is dangerous? Really, another thing; not so dangerous; it's not dangerous but unpleasant. It is the problem connected with the enormous demand of capital inflow. Last week, the Central Bank increased its currency reserves by approximately 5 percent, by $3.6 billion, one week. And in the Russian circumstances, the government, the Central Bank are trying to do everything they can to sterilize excessive liquidity. I cannot tell that they are not trying, but it is not the easiest situation.

And that means, well, usually, each year during the last three years, they were able to cut the inflation rate by approximately 2 percent. Last year, it was around 13 percent. So if we could be able to be on the tracks or to make it 11 percent, I would be extremely satisfied with the development.

The problem is that in the present circumstances, not everything is in the hands of the government sector.

MR. ARON: We have time for one more question.

MR. MORRIS: Yes, my name is Steven Morris, and I'm from Australia.

[Laughter and applause.]

MR. MORRIS: And we would be very happy for you to come again.

PRIME MINISTER GAIDAR: Thank you.

[Laughter.]

MR. MORRIS: I have a question with regard to the charitable activities of the wealthy, and you have referred to them as creating civil society actions. Of course, another way to look at it is creating a social safety net, which was formerly the function of the Party-State structures. Now, in the light of your response to a previous question, I'd like to ask you do you believe now that we're going to see a decline in the social safety net because of a decline in the charitable activities by the rich, or, secondly, are we going to say it more integrated into the direction the state wants it to go?

PRIME MINISTER GAIDAR: The second variant; more than this, they will be pushed to engage in these projects but only in the projects which are directly supported by the state.

MR. ARON: Thank you very much.

[Applause.]

MR. ARON: I suppose I need to formally close the conference. Thank you all very much for coming.

[Whereupon, the session concluded.]